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The following text is a
quote from the book A Short History of Financial Euphoria by John
Kenneth Galbraith. I found this material to be very fitting and for that
reason I wanted to share it with you.
“Anyone taken as an
individual is tolerably sensible and reasonable…as a member of a crowd,
he at once becomes a blockhead.” …Friedrich Von
Schiller, As quoted by Bernard
Baruch
That the free-enterprise
economy is given to recurrent episodes of speculation will be agreed.
These--great events and small, involving bank notes, securities, real estate,
art and other assets or objects--are, over the years and centuries, part of
history. What have not been sufficiently analyzed are the features common to
these episodes, the things that signal their certain return and have thus the
considerable practical value of aiding understanding and prediction.
Regulation and more orthodox economic knowledge are not what protect the
individual and the financial institution when euphoria returns, leading on as
it does to wonder at the increase in values and wealth, to the rush to
participate that drives up prices, and to the eventual crash and its sullen
and painful aftermath. There is protection only in a clear perception of the
characteristics common to these flights into what must conservatively be
described as mass insanity. Only then is the investor warned and saved.
There are, however, few
matters on which such a warning is less welcomed. In the short run, it will
be said to be an attack, motivated by either deficient understanding or
uncontrolled envy, on the wonderful process of enrichment. More durably, it
will be thought to demonstrate a lack of faith in the inherent wisdom of the
market itself.
The more obvious features
of the speculative episode are manifestly clear to anyone open to
understanding. Some artifact or some development, seemingly new and
desirable--tulips in Holland, gold in Louisiana, real estate in Florida, the
superb economic designs of Ronald Reagan--captures the financial mind or
perhaps, more accurately, what so passes. The price of the object of
speculation goes up. Securities, land, objets
d’art, and other property, when bought today, are worth more tomorrow.
This increase and the prospect attract new buyers; the new buyers assure a
further increase. Yet more are attracted; yet more buy; the increase
continues. The speculation building on itself provides its own momentum.
This process, once it is
recognized, is clearly evident, and especially so after the fact. So also, if
more subjectively, are the basic attitudes of the participants. These take
two forms. There are those who are persuaded that some new price-enhancing
circumstance is in control, and they expect the market to stay up and go up,
perhaps indefinitely. It is adjusting to a new situation, a new world of
greatly, even infinitely increasing returns and resulting values. Then there
are those, superficially more astute and generally fewer in number, who
perceive or believe themselves to perceive the speculative mood of the
moment. They are in to ride the upward wave; their particular genius, they
are convinced, will allow them to get out before the speculation run its
course. They will get the maximum reward from the increase as it continues;
they will be out before the eventual fall.
For built into this
situation is the eventual and inevitable fall. Built in also is the
circumstance that it cannot come gently or gradually. When it comes, it bears
the grim face of disaster. That is because both of the groups of participants
in the speculative situation are programmed for sudden efforts at escape.
Something, it matters little what--although it will always be much
debated--triggers the ultimate reversal. Those who had been riding the upward
wave decide now is the time to get out. Those who thought the increase would
be forever find their illusion destroyed abruptly,
and they, also, respond to the newly revealed reality by selling or trying to
sell. Thus the collapse. And thus the rule, supported by the experience of
centuries: the speculative episode
always ends not with a whimper but with a bang. There will be occasion to
see the operation of this rule frequently repeated.
So much, as I’ve
said, is clear. Less understood is the mass psychology of the speculative
mood. When it is fully comprehended, it allows those so favored to save themselves from disaster. Given the pressure of this crowd
psychology, however, the saved will be the exception to a very broad and
binding rule. They will be required to resist two compelling forces: one, the
powerful personal interest that develops in the euphoric belief, and the
other, the pressure of public and seemingly superior financial opinion that
is brought to bear on behalf of such belief. Both stand as proof of Schiller’s
dictum that the crowd converts the individual from reasonably good sense to
the stupidity against which, as he also said, “the very Gods Themselves
contend in vain.”
Although only a few
observers have noted the vested interest in error that accompanies
speculative euphoria, it is, nonetheless, an extremely plausible phenomenon.
Those involved with the speculation are experiencing an increase in
wealth--getting rich or being further enriched. No one wishes to believe that
this is fortuitous or undeserved; all wish to think that it is the result of
their own superior insight or intuition. The very increase in values thus
captures the thoughts and minds of those being rewarded. Speculation buys up, in a very practical way, the intelligence of
those involved.
This is particularly true
of the first group noted above--those who are convinced that values are going
up permanently and indefinitely. But the errors of vanity of those who think
they will beat the speculative game are also thus reinforced. As long as they
are in, they have a strong pecuniary commitment to belief in the unique personal
intelligence that tells them there will be yet more. In the last century, one
of the most astute observers of the euphoric episodes common to those years
was Walter Bagehot, financial writer and early editor of The Economist. To him we are indebted for the observation
that “all people are most credulous when they are most happy.”
Strongly reinforcing the
vested interest in euphoria is the condemnation that the reputable public and
financial opinion directs at those who express doubt or dissent. It is said
that they are unable, because of defective imagination or other mental
inadequacy, to grasp the new and rewarding circumstances that sustain and
secure the increase in values. Or their motivation is deeply suspect. In the winter of 1929, Paul M. Warburg,
the most respected banker of his time and one of the founding parents of the
Federal Reserve System, spoke critically of the then-current orgy of
“unrestrained speculation” and said that if it continued, there
would ultimately be a disastrous collapse, and the country would face a
serious depression. The reaction
to his statement was bitter, even vicious. He was held to be obsolete in his
view; he was “sandbagging American prosperity”; quite possibly,
he was himself short in the market. There was more than a shadow of
anti-Semitism in this response.
Later, in September of
that year, Roger Babson, a considerable figure of the time who was diversely
interested in statistics, market forecasting, economics, theology, and the
law of gravity, specifically foresaw a crash and said, “it may be
terrific.” There would be a 60- to 80- point drop in the Dow, and, in
consequence, “factories will shut down…men will be thrown out of
work…the vicious circle will get in full swing and the result will be a
serious business depression.”
Babson’s forecast
caused a sharp break in the market, and the reaction to it was even more
furious than that to Warburg’s. Barron’s said he should not be
taken seriously by anyone acquainted with the “notorious
inaccuracy” of his past statements. The great New York Stock
Exchange house of Hornblower and Weeks told him its
customers, in a remarkably resonant sentence, that “we would not be
stampeded into selling stocks because of a gratuitous forecast of a bad break
in the market by a well-known statistician.” Even Professor Irving
Fisher of Yale University, a pioneer in the construction of index numbers,
and otherwise the most innovative economist of his day, spoke out sharply
against Babson. It was a lesson to all to keep quiet and give tacit support
to those indulging their euphoric vision.
Without, I hope, risking
too grave a charge of self-gratification, I might here cite personal
experience. In the late winter of 1955, J. William Fulbright, then the
chairman of the Senate Banking and Currency Committee, called hearings to
consider a modest speculative buildup in the securities market. Along with
Bernard Baruch, the current head of the New York Stock Exchange, and other
authorities real or alleged, I was invited to testify. I refrained from
predicting a crash, contented myself with reminding the committee at some
length as to what had happened a quarter of a century earlier, and urged a
substantial protective increase in margin requirement--down payments on the
purchases of stocks. While I was testifying, the market took a considerable
tumble.
The reaction in the next
days was severe. The postman each morning staggered in with a load of letters
condemning my comments, the most extreme threatening what the CIA was later
to call executive action, the mildest saying that prayers were being offered
for my richly deserved demise. A few days later I broke my leg in a skiing
accident, and the newsmen, seeing me in a cast, reported the fact. Letters
now came in from speculators saying their prayers had been answered. In a
small way I had done something for religion. I posted the most compelling of
the communications in a seminar room at Harvard as an instruction to the
young. Presently the market recovered, and my mail returned to normal.
On a more immediately
relevant occasion, in the autumn of 1986, my attention became focused on the
speculative buildup then taking place in the stock market, the casino
manifestations in program and index trading, and the related enthusiasms
emanating from corporate raiding, leveraged buyouts, and the
merger-and-acquisitions mania. The New
York Times asked me to write an article on
the subject; I more than willingly complied.
Sadly, when my treatise
was completed, it was thought by the Times editors to be too alarming. I
had made clear that the markets were in one of their classically euphoric
moods and said that a crash was inevitable, while thoughtfully avoiding any
prediction as to precisely when. In early 1987, the Atlantic published with pleasure what the Times had declined. (The Times
later relented and arranged with the Atlantic
editors for publication of an interview that covered much of the same
ground.) However, until the crash of October 19 of that year, the response to
the piece was both sparse and unfavorable. “Galbraith doesn’t
like to see people making money” was one of the more corroding
observations. After October 19, however, almost everyone I met told me that
he had read and admired the article; on the day of the crash itself, some 40
journalists and television commentators from Tokyo, across the United States,
and on to Paris and Milan called me for comment. Clearly, given the nature of
the euphoric mood and the vested interest therein, the critic must wait until
after the crash for any approval, not to say applause.
To summarize: The
euphoric episode is protected and sustained by the will of those who are
involved, in order to justify the circumstances that are making them rich.
And it is equally protected by the will to ignore, exorcise, or condemn those
who express doubts.
Before going on to look
at the great speculations of the past, I would like further to identify the
forces that initiate, sustain, and otherwise characterize the speculative episode
and which, when they recur, always evoke surprise, wonder, and enthusiasm
anew. All this we will then see in nearly invariant form occurring again and
again in the history I here record.
Tim Wood
Editor, Cyclesman.com
Also
by Tim Wood
Copyright
© 2004-2008 by Tim W. Wood. All rights reserved.
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